Carbon without compulsion

Interest in using the carbon market to offset greenhouse gas emissions has soared. But the market’s dramatic growth raises questions of credibility and transparency. Christopher Cundy reports

A gap is emerging, it seems, between growing public concern about climate change, and the speed at which mandatory controls on greenhouse gas (GHG) emissions are taking effect. In response, organisations are turning to voluntary efforts, and barely a day goes by without another declaring that it will offset the emissions from its operations and go ‘carbon neutral’, or unveiling a new climate-friendly product or service.

A thriving business has developed to serve this demand for voluntary offsets. Money paid for each tonne of carbon dioxide funds projects as diverse as planting mango trees in India or the capture of methane from animal waste in the US. Alongside the project developers and offset retailers, brokers, traders, registries and investment funds operate in the voluntary markets – in almost a complete mirror of the mandatory carbon markets that were kick-started by the Kyoto Protocol.

But, in comparison with mandatory schemes, the voluntary market is much smaller, more fragmented and faces more questions over the credibility of the reductions offered, say market observers.

The first voluntary carbon transactions took place in the late 1980s, many years ahead of the regulatory markets created by Kyoto. US electricity company AES is generally acknowledged to have made the first investment to offset emissions, in a forestry project in Guatemala. In 1997, organic yoghurt maker Stonyfield Farm became the first carbon-neutral company, offsetting the GHG emissions from its manufacturing facility in New Hampshire.

Setting off: more and more holidaymakers are also looking to offset

Judging the size of the market is quite a challenge, given its fragmentation and differing opinions over what constitutes a voluntary tonne.The World Bank’s State and Trends of the Carbon Market 2006 report says traded volumes in the voluntary and retail markets reached 6.05 million tonnes of carbon dioxide- equivalent (Mt CO2e) in 2005, out of a total carbon market of 374Mt.

Most participants reckon the voluntary market has at least doubled in 2006 and is on a steep upwards trajectory. A recent report from consultancy ICF International forecasts that, by 2010, there will be voluntary demand for 400Mt of CO2e reductions (a figure not directly comparable with the World Bank calculation, which covers only signed contracts, including forward contracts). Approximately three-quarters of this demand is expected to come from organisations, and one-quarter from individual buyers, says the report’s Londonbased author, Eric Lounsbury.

But some feel the publicity around carbon offsetting has pushed the market ahead of itself.“The hype in the market has outstripped the reality of volumes,” says Mark Trexler, president of climate change consultancy Trexler Climate + Energy Services, based in Portland, Oregon.

“We have companies calling us that want to offset 1 or 2 million tonnes by themselves.We are seeing some very robust numbers being talked about. But people aren’t putting large amounts of money in yet,” he says.

Companies are choosing to engage for four main reasons, says Lounsbury. “Some wish to build a reputation for environmental stewardship and are choosing offsetting as one of the components of their climate strategy. Others recognise that participating in voluntary carbon markets is excellent preparation for future life under a mandatory capand- trade scheme.

“Some companies that have begun to use offsets are doing so based on the principle that it is a means of sharing the responsibility for managing emissions between producers and consumers,” he says.

Competitiveness is the fourth reason. “Because climate change is an increasing concern to consumers, there’s an opportunity to position products accordingly,” Lounsbury adds (see pages S8–S9).

Some argue that voluntary carbon markets have an essential role to play in slowing climate change. Mitchell Feierstein, head of emissions at Cheyne Capital Management, a London-based asset manager with more than $9 billion under management, believes regulated markets alone will not be sufficient. In August 2005, the firm launched the world’s first voluntary carbon offset investment fund, the Cheyne Carbon Fund, to offer a source of verified emissions reductions (VERs) to companies, and is a major buyer of voluntary credits – although he declines to give figures.

He says greater responsibility for tackling global warming will fall at the feet of corporations, which will be forced by investors and financial regulators to disclose their carbon footprints and manage their future carbon liabilities – so driving demand for VERs.

Perhaps the most important question offset buyers need to ask is, what are they actually buying? With dozens of commercial and not-for-profit organisations (see pages S15–S17) in a relatively young sector offering carbon offsets, there are bound to be significant differences in the types and prices of offset on offer.

Many firms offer their ‘own brand’ of project-based VER, while some in the US convert renewable energy certificates (RECs) – which represent the ‘green’ attributes of power generated by renewable sources – into emission reductions. Others buy and retire EU allowances (EUAs) issued under the EU Emissions Trading Scheme, or buy from the Chicago Climate Exchange (CCX), the main voluntary market in the US. Some acquire certified emission reductions from the Clean Development Mechanism (CDM), a project scheme to supply credits to the Kyoto Protocol’s compliance markets.

Efforts are under way to establish standards, but at the moment it is a case of 'buyer beware'

Prices of voluntary offsets vary widely: the World Bank report says prices ranged from $0.65 to $9.36 per tonne of CO2 during 2005. A recent survey of offset providers by UK-based consultancy Context found that credits were sold to the public at prices from £2–25 ($4–50)/t.

However, both critics and proponents of offsets argue that this proliferation of offset types is holding back the growth of the markets – and say that some standardisation is required.

Such a standard could provide reassurance to a buyer that the offsets they are purchasing meets minimum environmental and social criteria and, most importantly, are ‘additional’ – that is, they would not have been generated without the money provided by the offset buyer.

But arguments over what is truly additional have rumbled on for years, and the actual ‘saving’ of carbon dioxide, especially in forestry projects, has been widely disputed.

For example, RECs are not a carbon reduction per se, but merely denote a quantity of electricity produced by a renewable energy technology, argue Trexler and others. For their part, EUAs are a permit to pollute. Buying and retiring these kinds of credits does support the renewable energy and carbon markets, but arguments rage over their additionality.

“Everyone recognises that there is a need for standardisation. It’s the largest bottleneck in the market,” says Kristian Brüning, Helsinkibased director of Climate Wedge, a consultancy and an adviser to the Cheyne Carbon Fund.

In its carbon market report the World Bank notes:“The single biggest impediment to stronger demand and a predictably higher price for [VERs] remained the lack of a broadly accepted standard for voluntary projects that combined simplicity and consistent integrity, qualities which should make them welcome across regulatory regimes and voluntary markets.”

Corporate and personal reputations are at risk from low-quality credits

Efforts are under way to establish standards (see pages S10–S11 and News, page 6), but at the moment it is a case of ‘buyer beware’ or, as Trexler explains, buyer dictates. “Companies could step up and say ‘This is what we are willing to buy’.We are suggesting this as an alternative to them wringing their hands over what standards to use,” he says. High-volume offsetters can, and frequently do, fund entire projects, which allows them to ensure additionality and maintain quality control.

Cheyne Capital’s Feierstein believes the Voluntary Carbon Standard (VCS) – a standard under preparation by the Climate Group and the International Emissions Trading Association – is fundamentally what the market needs. “There’s a real need for a robust and fungible voluntary market where reductions are permanent, quantifiable and scaleable – and where every credit is certified and verified by a designated operational entity [a verification company, such as DNV, SGS or TÜV] accredited by the UN Framework Convention on Climate Change.”

“We believe the way to go forward is to invest in [carbon abatement] projects that are highly credible, provide genuine environmental benefits and facilitate additional investment towards sustainable development. We don’t rule anything out, but we currently will not invest in forestry or certain agricultural gases due to the uncertainties associated with those sectors.”

Until the VCS was announced, he says, there had been no coordinated effort to create a quality product and bring it to market. But there is every reason to do so, as corporate and personal reputations are at risk from low-quality credits sold by non-creditworthy counterparties, which offer buyers no financial or legal recourse.“We believe quality voluntary carbon units will command a premium in voluntary markets of the future,” Feierstein says.

Consumers with similar concerns about standards can turn to a recent report from Trexler, commissioned by campaign group Clean Air, Cool Planet. It ranks eight “top performing” retail offset providers according to seven criteria, such as transparency and understanding of offset quality.

Many argue that turning away from voluntary carbon, or trying to saddle it with regulations, risks stiffling innovation

“It’s been an interesting project,” says Trexler, who usually declines to write consumer reports. “It was almost immediately boycotted by a group of companies concerned about how we would treat the use of RECs as carbon offsets.”

In June 2006, Bank of New York (BoNY) added a cornerstone of credibility to the market by opening a registry for corporate buyers and sellers trading voluntary credits. Offset sellers largely rely on in-house spreadsheets to record the creation, trade and retirement of project credits. Even though many are independently verified, buyers are exposed to a risk of ‘double counting’ – paying for a reduction that has already received financial support from a third party.

“Without registries, I don’t see how you can avoid double selling and I can’t see how offset users can really make sure there are emission reductions linked to their investment are happening,” says Michael Schlup, Basel-based director of The Gold Standard, an NGO-backed standard for offset projects.

Climate Wedge’s Brüning says: “Going forward, there needs to be more impetus on how these credits are treated. There are no public records as to how these credits are retired.The BoNY is the direction the market should go towards. It’s very robust.”

The Bank of New York registry is set up according to guidelines in the VCS, and credits can only be cleared if they meet the VCS criteria, explains Dario Parente, assistant vice president in the bank’s corporate trust services division in London. He says a wide variety of parties have shown interest, including hedge funds, NGOs and offset retailers. Currently there are no plans to release figures for cleared volumes, nor collect price information, he says.

The CarbonNeutral Company, one of the leading commercial and retail offsetters, has long promoted the need for common standards. According to chief executive Jonathan Shopley, “Offset has been a new emerging market, and there are inevitable teething problems with some suppliers when a new product is evolving in this way.”

The company has created its own standard, which Shopley says could be the basis for an industry-wide approach, and it is developing its own registry. It has, for several years, commissioned consultancy KPMG to verify its management of carbon offsets.

In an attempt to side-step the credibility question, some offset providers, such as UK-based charity Pure, will only buy credits from regulated schemes such as the EU ETS, the CDM and the CCX. But many see the voluntary and mandated markets as symbiotic, and argue that turning away from voluntary carbon, or trying to saddle it with regulations, risks stifling innovation in the emissions reduction sector.

“The key niche for voluntary carbon is to pursue projects that don’t quite fit the mould of the mandatory market. These could be smaller-scale projects using emissions reduction technologies or methodologies that aren’t yet approved by mandatory bodies,” says ICF’s Lounsbury.

Also, there are many countries and sectors that fall outside mandatory schemes, where good projects can mobilise carbon funding.“The voluntary market acts as a lubricant to the mandatory market. It operates in the areas where mandatory doesn’t – it’s not competing,” explains Climate Wedge’s Brüning.

How much carbon dioxide has been saved from entering the atmosphere by voluntary efforts so far is anyone’s guess, but that is not the sole benefit of the market. “We tend to view the voluntary market as just as much about education and development. In the long term, we might conclude that was its important role,” says Trexler.